Jane Dotson
An individual purchasing life insurance may establish an Irrevocable Life Insurance Trust (ILIT) to reduce the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary. The death benefit of a life insurance policy is typically included in the gross estate of the owner and insured, but when owned by an ILIT, the proceeds are not subject to estate taxation. In addition to tax benefits, an ILIT can provide asset protection and control over the distribution of proceeds. However, it's important to note that establishing an ILIT involves irrevocability, potential gift tax implications, complexity, and cost.
| Characteristics | Values |
|---|---|
| Main purpose | To decrease the value of an individual's estate in order to reduce the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary |
| Tax advantages | Avoiding gift tax consequences; providing tax-free death benefit; reducing current tax burden; minimising estate taxes |
| Control | Allowing the grantor to direct how and when the death benefit is used and for whom; protecting insurance benefits from divorce, creditors, and legal action |
| Liquidity | Providing cash to cover estate taxes and other expenses to avoid having to sell a business or other high-value assets |
| Asset protection | Protecting assets from creditors; protecting inherited assets from inadvertently interfering with a beneficiary's eligibility for government benefits |
| Irrevocability | Cannot be amended or revoked once established |
| Complexity and cost | Requires regular maintenance and incurs professional fees |
| Three-year rule | If the grantor passes away within three years of transferring an existing life insurance policy into an ILIT, the policy's value could still be included in their taxable estate |
What You'll Learn
To reduce estate tax
One of the primary reasons an individual purchasing life insurance might establish an irrevocable life insurance trust (ILIT) is to reduce estate tax. Here's a detailed explanation of how this works and why someone might choose to do it:
When an individual passes away, their estate may be subject to estate taxes, which are levied on the transfer of property after death. The
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To protect assets
An Irrevocable Life Insurance Trust (ILIT) is a powerful tool for protecting assets. It is a legal arrangement that transfers assets from the individual to the trust, using a life insurance policy to distribute the proceeds to beneficiaries when the grantor passes away. The proceeds from the death benefit are not part of the insured's gross estate and are thus shielded from estate taxes. This is particularly useful for high-net-worth individuals, as it can lower their current tax burden and the impact of taxes on their estate.
ILITs also protect assets from creditors. Each state has different rules and limits regarding how much cash value or death benefit is protected, but generally, any coverage held in an ILIT is protected from the creditors of the grantor and/or beneficiary. This ensures that the life insurance proceeds are protected and can be distributed according to the grantor's wishes.
The trustee of an ILIT has discretionary powers to control distributions and decide when beneficiaries receive proceeds. This can be useful for ensuring that young or financially inexperienced heirs do not mismanage funds and for protecting assets from lawsuits and divorcing spouses. The trustee can also ensure that distributions are used in a way that does not interfere with the beneficiary's eligibility for government benefits.
ILITs can also provide liquidity to help pay estate taxes and other expenses, preventing the need to sell high-value assets such as a family business, farm, or home. This helps to maintain the value of the estate and ensures that beneficiaries receive their inheritance in a timely manner.
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To ensure beneficiaries receive proceeds
An Irrevocable Life Insurance Trust (ILIT) is a legal agreement where a life insurance policy is placed into a trust, removing it from the grantor's estate to provide asset protection, estate tax benefits, and control over the distribution of proceeds. The grantor, who is typically the insured, creates and funds the ILIT. The trustee then manages the ILIT and ensures that the beneficiaries receive the assets held in the trust.
The trustee of an ILIT has discretionary powers to make distributions and control when beneficiaries receive the proceeds of the policy. The trustee can distribute proceeds to beneficiaries immediately or according to milestones specified by the grantor, such as graduating from college, buying a first home, or having a child. The trustee can also ensure that the proceeds are used for specific purposes, such as a college education, until the beneficiary reaches a certain age.
ILITs can help ensure that beneficiaries receive the proceeds of the life insurance policy by providing tax savings and asset protection. ILITs keep life insurance proceeds out of the taxable estate of the insured, potentially saving the beneficiaries thousands or even millions in estate taxes. ILITs also shield assets from creditors and lawsuits, providing a secure financial future for the beneficiaries.
In addition, ILITs can help solve liquidity problems by allowing the trustee to purchase an estate's assets. The proceeds from the sale of these assets can then be used by the beneficiaries to pay estate taxes while still maintaining control of the estate's assets. ILITs can also be used to mitigate the generation-skipping transfer tax, which is a tax of up to 40% on gifts to people more than 37.5 years younger than the gift giver. By placing the life insurance policy into an ILIT, the grantor can help ensure that the beneficiaries receive the full proceeds of the policy without incurring additional taxes.
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To avoid gift tax consequences
An individual purchasing life insurance may establish an ILIT to avoid gift tax consequences. Here are some key points to consider:
Understanding Gift Taxes
Firstly, it is important to understand how gift taxes work. In 2025, an individual can give up to $19,000 per year to another individual without reporting it to the Internal Revenue Service (IRS). A married couple filing jointly can give up to $38,000 combined without reporting. If the gifts exceed these amounts, they must be reported using Form 709. However, taxes are generally only owed if the gifts exceed the lifetime gift exemption amount, which is $13.99 million for individuals and $27.22 million for married couples in 2025.
Role of the Trustee
When establishing an ILIT, the trustee plays a crucial role. The trustee is responsible for managing the trust, paying insurance premiums, and overseeing administration. The trustee uses the assets transferred to the trust to purchase a life insurance policy in the grantor's name and ensures the policy remains in force by paying the premiums. Upon the death of the grantor, the trustee collects the death benefit and distributes it to the named beneficiaries.
Avoiding Gift Taxes with ILIT
Now, let's understand how ILIT helps avoid gift tax consequences. When an individual transfers ownership of a life insurance policy to an ILIT, they are essentially gifting the policy to the trust. If the value of the policy exceeds the annual gift tax exclusion amount, it can trigger gift taxes. However, with proper planning and the use of a Crummey letter, gift taxes can be avoided. A Crummey letter is a notification sent to the beneficiaries informing them of their right to withdraw a share of the contribution. By following this procedure, deposits and premium payments up to the annual gift tax exclusion amount can be made without gift tax consequences.
Additional Benefits of ILIT
In addition to avoiding gift taxes, ILIT offers several other benefits. It removes the value of the life insurance policy from the grantor's taxable estate, reducing estate taxes. ILIT also provides asset protection, shielding the insurance proceeds from creditors. Furthermore, ILIT can help protect government benefits for beneficiaries, ensuring that the inherited assets do not interfere with their eligibility for programs like Medicaid or Social Security Disability Income.
Considerations and Complexities
While ILIT offers tax advantages, it is important to consider certain complexities. ILITs are irrevocable, meaning once established, they cannot be changed. This loss of control over the insurance policy and the trust is a significant decision that requires careful consideration. Additionally, ILITs can be complex and require regular maintenance, such as paying premiums through the trust, and there are costs associated with setting up and administering the trust. Consulting with qualified professionals is essential to ensure the ILIT is appropriately structured and funded.
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To protect government benefits
An individual purchasing life insurance may establish an Irrevocable Life Insurance Trust (ILIT) to protect government benefits. ILITs are a powerful tool that can be considered in wealth management plans to ensure that a policy is used to benefit the policyholder's family.
ILITs are particularly useful for those seeking to provide lifetime care for a family member with special needs. In such cases, careful estate planning is essential to ensure that inherited assets do not interfere with a beneficiary's eligibility for government benefits such as Social Security Disability Income or Medicaid. By transferring ownership to a trust, it becomes easier for beneficiaries to qualify for Medicaid and other government assistance programs. The trustee can carefully control how distributions from the trust are used, ensuring that continued benefit eligibility is maintained.
For example, if the death benefit was paid in full immediately, the beneficiary may be forced to surrender government assistance. With an ILIT, there is more control over how and when money is distributed to beneficiaries, allowing for careful planning to ensure that government benefits are not disrupted.
In addition to protecting government benefits, ILITs offer several other advantages. They can provide a tax-free death benefit, protect insurance benefits from divorce, creditors, and legal action, and avoid probate, shielding assets from expense and loss of privacy. ILITs also provide liquidity to fund a business succession plan or to avoid selling illiquid assets, such as a family business, farm, or home. They can help equalize inheritance among multiple beneficiaries and provide flexibility in directing how and when the death benefit is used.
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Frequently asked questions
An Irrevocable Life Insurance Trust (ILIT) is a legal arrangement that transfers assets from one party (you) to another (the trust). It uses a life insurance policy to efficiently distribute proceeds when you pass away.
The main benefit of an ILIT is that it helps to reduce the estate tax paid on the life insurance benefits passed from the grantor to the beneficiary. It also protects assets from creditors and legal action, and gives you more control over how the proceeds are distributed.
The main drawback of an ILIT is that it is irrevocable. This means that once you establish an ILIT, you cannot change your mind and you lose control over the insurance policy and the trust. There may also be costs associated with setting up and administering the trust.
